Lower interest rates ‘helping’ economy get going again

As the nation’s economy slowed down the past year, the Federal Reserve Bank dropped interest rates again and again. Some doubted whether the interest rate cuts were effective as layoffs and plant closings continued.

But these last two interest rate cuts seem, at last, to be sparking renewed consumer confidence and spending.

“It’s helping,” said State Economist Dr. Phil Pepper. “Lower rates without nearly any inflation are a great help to try to get the economy moving again.”

Consumer spending in October showed its largest one-month gain in history. Retail sales were up 7.1% with all but 1% represented by sales of vehicles spurred by offers of 0% interest financing.

The flip side of the buying spree sparked by the zero interest loan programs is that automakers are losing millions with their loan programs, and stealing sales from next year. However, Pepper says the lower interest rates mean the car company’s zero interest plans are costing less. And he said it is more important right now to stimulate the economy than worry about corporate profits that might take a hit later on.

“What we are looking for now is something to jumpstart the economy,” Pepper said. “The car industry is doing that by generating sales and sales tax. It is helping to get the economy moving again. It will hurt car company profits in the longer run. But, from the economy’s perspective, it is helping the economy today.”

Another advantage of the lower interest rates is the amount of mortgage refinancing activity it has generated. Refinancing a mortgage can reduce payments by hundreds per month, which frees up homeowners to have a steady income stream to buy other things including large ticket items.

Eddie Maloney, president of Cowboy Maloney’s, said appliance sales are picking up. Low interest rates have allowed companies like his to offer low-rate or even free financing.

“Our brethren in the auto industry have caught on to financing programs we have been using for three or four years, and realizing they do drive a lot of business,” Maloney said. “It makes it attractive to buy a new car just like to buy appliances.”

Maloney said another advantage of the lowest interest rates is that it makes financing more available to marginal creditworthy customers.

Banks both across the country and in Mississippi are seeing record levels of refinancing activity, according to Paul Guichet, vice president of investor relations for Hancock Bank on the Mississippi Coast.

“It is beneficial for consumers to re-evaluate where they are as far as interest,” Guichet said. “And you are looking at record lows.”

The low rates could send investors elsewhere looking for greater returns. But Guichet says CDs still have their appeal for depositors looking for safety and soundness. Currently he is seeing many investors putting their money in short-term, liquid- type accounts waiting to see when the economy will turn around and interest rates will be more encouraging.

Prudent approach

“Basically now folks are sitting on the sidelines staying pretty liquid so they have flexibility and access to funds if needed,” Guichet said. “They are looking to see what happens as far as the economy and the effort in Afghanistan. People are taking a prudent approach. They don’t want to extend themselves until they see where the economy is going to head. From what I see, analysts and economists believe somewhere around the third quarter of next year we will see an improvement in the economy. So we just have to be patient and let this go its natural course.”

The overall economic conditions with massive layoffs across the country mean that some lenders have started to readdress their credit criteria, says John Allison, commissioner, Mississippi Department of Banking and Consumer Finance.

“We can see some cutback on credit,” Allison said. “We certainly aren’t advocating that because money needs to be in the economy. But banks are back to the old, conservative ways of looking at things. That long ride of higher earnings for the past nine years solved a lot of problems. Last year was the first time in nine years that there were not record earnings at banks.”

That near decade of great earnings created strong loan reserves. During those profitable years, a mistake on a loan wasn’t nearly so important. Now with the shrinking of interest margins, banks aren’t making as much as in the past.

“If you look at their earnings now, it is still good but it is not like it was three or four years ago,” Allison said. “For example, ROA (return on assets) was at 1.5 and now it is back to 1 or a little under. One used to be the traditional benchmark that banks strived

for.”

Allison said if the last rate reduction and inflation are taken into consideration, the cost of money is theoretically zero or less. So if people need money and they have good credit habits and collateral that indicates the ability to repay, there is plenty of funding to be had.

But, if a loan applicant is shaky, the bank will be more leery of lending or may charge a higher interest rate because risk determines the rate. Softness in the economy in the past has been localized in the state, but Allison said this time the economic slowdown is not confined to just one area of the state. It is pretty much all over.

“One thing that goes unnoticed is the number of manufacturing jobs that are in Mississippi,” Allison said. “It is tremendous. And we have lost well over 20,000 jobs in the last 18 months, which is very significant. Another way to put it is if Nissan was on line with their maximum employment and all suppliers at maximum employment, we would maybe be back to zero. There would be no net increase of jobs. Nissan and their suppliers will have in the neighborhood of 20,000 to 25,000 jobs.”

Another troubling sign is that previously a lot of plants would close temporarily during an economic downturn. But this time plants are closing with no plans to open back up when the economy rebounds.

It takes five to six months for interest rate decreases to be totally effective in the economy. That means that from the last interest rate cut, it would be late second quarter of 2002 before the rate cut is effective in the economy. Allison said a rebound even in the late second quarter is probably being a bit optimistic.